Warning All Investors -  HST Shock To Hit Ontario?

By Guest Columnist, Gordon Pape

The problem arises from the fact that the 5% GST is applied to certain financial services, including mutual fund management fees, while provincial sales tax is not. As a result, investors currently pay an additional 0.1% on a 2% management charge.

If the harmonized sales tax (HST) goes through as planned, the combined rate would be 13% which would increase the tax on a 2% management fee to 0.26%. The average management expense ratio (MER) on Canadian mutual funds is already one of the highest in the world. Such an increase would only add to the costs and would come directly out of investors' pockets in the form of reduced returns.

To complicate matters further, residents of other provinces also risk being hit by the increase even though it theoretically applies only in Ontario. That's because the majority of mutual fund companies are based in that province. It would be impossible for them to apply different tax standards elsewhere, raising the possibility that a Calgary resident buying an Ontario-based fund would be hit with a 13% tax on the management fee even though Alberta has no provincial sales tax.

This situation would also create a tax advantage for fund groups that are based outside Ontario, such as Investors Group which is headquartered in Winnipeg.

Although three Atlantic provinces (New Brunswick, Nova Scotia, Newfoundland and Labrador) moved to an HST several years ago, this issue did not arise because no major fund companies are based there. But the announcement in the March Ontario budget that the province plans to implement a blended sales tax on July 1, 2010 has changed the whole picture.

"The federal government should be concerned that people outside Ontario are not subject to a harmonized tax," says Barbara Amsden, director of research and strategy for the Investment Funds Institute of Canada (IFIC). She met with officials of the federal Finance Department in Ottawa on Monday to discuss the issue but said afterwards they "did not seem impressed" with the request for some kind of relief.

Applying the HST to management fees would amount to a "tax on savings" she says, noting that Canada is the only value-added tax country in the world with sales taxes at two levels.

The logical solution would simply be to exempt mutual fund management fees and similar financial charges from the GST/HST. But doing so would cost cash-strapped governments hundreds of millions of dollars. As of the end of May, member companies of IFIC had $537.8 billion worth of assets under management. If we assume an average management fee of 1.5%, that works out to slightly more than $8 billion that is currently subject to the 5% GST, generating about $400 million tax dollars for Ottawa. Amsden points out this is a huge windfall for the government as the fund industry has grown by almost 20 times since the GST was first introduced.